Thursday, June 04, 2009

Some Realistic Suggestions About Owning and Renting

Last Thursday, I continued my jeremiad against individual home ownership. The essence of my argument is that the social pressure to own a home -- pressure that is reflected in many different public policies -- is harmful to both individuals and society in ways that go far beyond the immediate housing-initiated economic crisis. Because of my professional habits, I focused on the tax advantages conferred on home ownership and suggested that we should eliminate those advantages if we want to solve the underlying problem. Today, I will begin to explore some politically realistic ways to deal with the problem.

To summarize, the biggest problem with individual home ownership is that it concentrates risks in ways that can be ruinous to people whose homes lose value. Moreover, this personal tragedy can become a problem for the rest of the country when people are, to put it simply, stuck where their houses are but the jobs are not. Also, as one of the comments on my recent post noted, the long-term average annual rate of return on a house -- over a long enough period to smooth out the cyclical factors -- is on the order of 1%. Even without bad luck in the timing of a sale, this is not a great way to invest. Yet we continue to encourage it.

In two of the tax-apalooza sessions at the Law & Society conference last weekend, the wisdom and political salience of the mortgage interest deduction came up for discussion. In one session, UC Davis's Dennis Ventry presented a paper whose title says it all: "The (Ignominious) Rise and (Predicted) Fall of the Home Mortgage Interest Deduction." Ventry's analysis focuses on the political history of the deduction, but as a normative matter, it seems fair to say that his scholarly analysis confirms what I have written here and on FindLaw about the foolishness of allowing a tax deduction for home mortgage interest.

While Ventry predicts the eventual repeal of the deduction, however, I was caught short by a comment at another session. Discussing the history of California's property tax revolt that led to Prop 13, a political scientist commented that the mortgage interest deduction was incredibly important to her personally and stated quite emphatically that, if it were taken away, there would "be a revolt." If even well-trained academics are this viscerally attached to the tax deduction, it is probably worthwhile to think about ways to mitigate the harms of individual home ownership other than through the elimination of existing tax advantages.

As an initial matter, as the last commenter on my post last Thursday also pointed out, it should be possible to solve the problem not by discouraging individual home ownership but by making it less harmful to individuals and society when homes lose value. Theoretically, it should be possible to insure against losses in the price of one's home in a way that spreads those risks, just as insuring against all other perils can spread risk. Encouraging "loss in housing price insurance" would thus be one way to make it possible to own one's own home without really having all one's financial eggs in one basket.

As it stands, however, that market has clearly failed. If we can make it work better, then we could allow people to indulge their desire to own their castle without putting themselves and society at risk. If we cannot do that, however, we need to think about other ways to prevent people from wanting to buy homes when they really should not be a homeowner. How might that work?

First, as a matter of public education, it is surely worth publicizing the fact that the home mortgage interest deduction (and the deduction for property taxes, for those who are not subject to the Alternative Minimum Tax) do not automatically make home buying superior to renting. In many if not most markets, the price of homes has fully "capitalized" the value of the tax deductions -- that is, the price of the house itself has risen to reflect the value of the tax deduction, so that the buyer has the same net monthly payments that she would have if there were no tax deductions (and lower house prices). Letting people know that owning one's home is not a "special deal" would surely move us in the right direction.

This also, by the way, suggests that eliminating the tax deductions might have an effect on home ownership only inasmuch as doing so would make a symbolic statement about the value of home ownership. If the elimination of the tax deductions would (after the transitional effect of lowering the prices of existing homes, losses that would need to be compensated in any plan to change the tax laws) not change the actual cost of owning a home, then the only way that such elimination could shift people into rentals would be to send the message that "society no longer thinks that home ownership is importance enough to subsidize." Again, however, the counter-intuitive nature of such a symbolic statement is what would surely derail attempts to enact the desired change in the tax laws.

Even if we cannot discourage home ownership directly, however, we can surely start to enact policies that would make rental markets operate more smoothly. This is a situation where the thinness of the market is the essence of the problem. In that way, it is like the issues that arise with veganism, as I pointed out in twoposts last summer. When there are too few potential buyers of a particular type, there is no reason for sellers to accommodate that group of buyers; but when a critical mass is reached, the situation can improve "on its own" dramatically. The role for public policy, therefore, is to try to push the market in a direction that will allow it to become deep enough and mature enough that the only role for public policy going forward would be to maintain the background rules of contract law, public health, etc.

As another comment on last Thursday's post pointed out, the current transaction between landlords and tenants looks very one-sided. It is surely possible and desirable for the laws governing tenancy to be changed in ways that right that balance. I have suggested in earlier posts, however, that the movement of people who are not financially marginal into the market for renting will itself tend to change the way that landlords act. When I lived in Manhattan, I rented a rather expensive (even by New York standards) apartment; and even though I signed a "take it or leave it" contract, the content of that contract was much more favorable to renters than any rental contract that I had seen before then. The market for luxury apartments there is well-developed enough that the existing norms and laws provide an even playing field for renters.

More directly, even if we cannot eliminate the tax deductions for home ownership, we could allow a federal deduction for any housing-related expense, including rent. Many states already allow this. Again, even if this tax change is fully absorbed into the ultimate prices, the legal equivalence of buying and renting could change the way people view their housing decisions.

Perhaps the most promising possibility, however, is uniquely available to us because of the current housing crisis. With the large number of foreclosures, the federal government has been busily looking for ways to keep people in their homes. It would surely be possible to encourage more lenders to allow people to continue to live in their homes after foreclosure. Even if the lenders do not want to become property managers, targeted incentives should make it worthwhile for them either to begin to do so on their own or to hire property management companies to handle the new renters' needs.

The bigger point is that there appear to be ways around the political inviolability of the tax deductions for home ownership. The essential point that I have been pressing in these blog posts has been that owning and renting are different in form but not substance. Public policies can exploit that equivalence by avoiding the bad public relations of seeming to attack home ownership and instead "expanding freedom of choice." Isn't that the American Dream, too?

8 comments:

One small observation re the 1% number: If the annual return (over the long run) on a housing investment is 1% but the typical homeowner is only putting down 10%, then the real rate of return is much higher. Of course, as with any investment on margin, this makes the downside risk all the greater--but that's a point about concentrated risk, not return. It might also be objected that for someone who holds the property for 30 years and pays off the mortgage, the real rate of return is 1% because that turns out not to be a margin purchase. But as Neil noted in his earlier post, the typical homeowner sells after about 7 years. So, again we have a very good expected rate of return, but the problem is concentrated risk.

I think you're dead right in your analysis. The problem, as you suggest, is getting from here to there. And on that score, there is one huge difficult, it seems to me. That problem is the relatively poor quality of rental housing. Have you tried to rent a three (or, if you have two or three kids, a four) bedroom apartment? There just aren't a lot of them, and when you find one, it is invariably going to be far inferior to a three bedroom house in the same neighborhood. That makes it difficult for a family to decide to rent, even if it would prefer to, all things equal. I, for one, would love to rent forever -- nothing beats not having to fix things yourself, knowing what your costs are going to be each month, and not having to assume the huge risk that leverage entails. Trouble is, when I have a family, renting will a decidedly inferior option simply in terms of the available renting housing stock. In other words, to have the kind of place I would want, I will have to opt to own.

One other thought. One of the downsides to renting is that a tenant can be asked to leave at the landlord's whim, or can be asked to pay dramatically increased rent. That makes rental housing less secure (especially if you have kids counting on the particular public school attached to the unit). With owning a home, one knows that if she can continue to pay the monthly price established at the time of purchase, she can stay in that home indefinitely. Owners, in other words, essentially have upside tenure in their homes. For renting to be a desirable substitute for owning, renters would need, I think, the equivalent protection against displacement and unpredictable rent increases, things likely to coincide with increases in the market value of the rental property they live in. I think it would consequently be essential to give renters very strong tenure rights in their units, through eviction protection and rent stabilization/control. I know rent control is, to many economists, a bugaboo. But it seems to me that the inefficiencies of rent control, when seen as a core part of fomenting a transition from an ownership society to a rental society, emerge as simply a small cost amid huge benefits. But it also highlights the obstacles that exist to the large transition that you and I both favor.

Mr. Dorf, your math is off. If you hold the house for 30 years you still had leverage during the term of the mortgage - it decreased over time but the real rate of return is still over 1%. To demonstrate, think of buying a home at 0% down for $100,000 at 1% interest for 10 years, paying off the mortgage and selling the house a day later for $150,000. The purchase is still margin even though there was one day where it was fully paid off from other cash. The rate of return would be the profit of $50,000 less the amount paid ($10,000) in interest over the amount paid - 400% - less a negligible adjustment for one day of return on $150,000. Basically, 399.99% return. For homeowners, the real rate of return decreases as the margin decreases (assuming a fixed, positive non-margined rate).